MEXICAN ENERGY REFORMS BRING BENEFITS AND CHALLENGES

The shale revolution changed the United States’ energy industry and set the country on a course to becoming an energy superpower. The combination of two technologies, hydraulic fracking and horizontal drilling, unlocked previously unobtainable oil and gas fields while increasing efficiency. Reserves are now higher than at any point since 1975. After suffering 30 years of declining oil production, the United States reversed this downward trend and produced more oil in January 2015 than in any month since January 1973. Texas alone is projected to become the eighth largest oil producer in the world in 2015, ahead of Mexico, Kuwait and Iraq.

In the natural gas market, U.S. production is predicted to reach 72.8 billion cubic feet in January, a record peak in gas production. With the success of the American energy industry, some have wondered if this success can be transferred to its neighboring country, Mexico. With new energy reforms passed last August, Mexico could potentially undergo an energy renaissance similar to that of the United States.

Historical Energy Reform Laws

The new energy reforms aim to make the Mexican energy industry more competitive and economically efficient in the face of declining oil production. Since 2004, oil production has declined from about 3,847,000 barrels a day to 2,907,000 barrels a day in 2013. The energy industry has suffered from underinvestment and a lack of human capital causing the decline in production. Without sufficiently trained engineers with technical expertise and modern technology, many oil and gas reserves remain unproductive. Part of the problem was the monopoly the state-owned energy company Pemex held over oil and gas production, and the restrictions on foreign investment in the energy sector.

The new laws signed by President Enrique Pena Nieto addressed these problems by ending Pemex’s monopoly and opening up the energy sector to foreign investment. Now foreign companies will be allowed to compete with state-owned companies in the bidding process for contracts and licenses on oil and gas fields. As early as July of this year, Mexico will offer the first oil and gas blocks to private companies, awarding access to 14 exploratory fields in the Gulf of Mexico. However, there are still some limitations on foreign investment. The oil and gas rights are still owned by the Mexican state. Foreign companies only receive the revenues from the sale of oil and gas. Regardless, the laws passed represent a big change in the Mexican energy landscape.

Fracking and Horizontal Drilling Opportunities

Investment from the United States will not only bring the money Mexico needs, but also the technological methods needed to extract unconventional oil and gas. Despite having the sixth largest shale gas reserves in the world, Mexico has only built a few shale wells, leaving the vast majority of reserves untouched. Part of the reason is that there are no Mexican companies with an expertise in fracking or horizontal drilling. Without these two techniques, Mexico cannot access the vast reserves of oil and natural gas locked up in shale formations. Mexico could potentially extract 62 billion barrels of oil in shale fields in northern and eastern Mexico and 29.5 billion barrels in deep-water fields if these techniques are used.

American companies see this as a new opportunity to expand their business and profits in a country where there is essentially no competition in fracking or horizontal drilling. By using American technology, much of Mexico’s unconventional oil and gas reserves can be unlocked. There is much optimism that this will be accomplished. Just after the passage of the reform laws, the Energy Information Administration increased Mexico’s 2040 oil forecasts by 75 percent.

If these technologies are used correctly, shale rich states such as Nuevo Leon can become new leaders in energy. The Governor of Nuevo Leon, Rodrigo Medina, stated that, “the goal is for Monterrey to become the new energy capital, from wind to shale…the Houston [or] Dallas of Mexico.” Texan businesses have already begun preparing to invest in Nuevo Leon, with business leaders and government representatives from Houston meeting with Nuevo Leon representatives last November 3 to discuss possible investment in the region. This type of investment and cooperation will link the economies of the United States and Mexico even closer.

Economic Benefits

The United States has already benefitted from many economic opportunities from as a result of fracking and horizontal drilling. According to a study from energy expert IHS, the shale energy boom increased the average household disposable income in 2012 by $1,200 and is predicted to grow to $2,700 by 2020. The industry also supported 2.1 million jobs in 2012.

A second shale boom in Mexico would provide more jobs and economic opportunities for Americans. American engineers and consultants will be in high demand to bring their expertise to Mexican shale fields. Nathaniel Karp, a chief economist for BBVA, testified at a Texas Senate subcommittee that the energy reforms could potentially add more than 217,000 jobs and $45 billion in GDP to the Texas economy. As profits from Texas fields begin to decline due to diminishing marginal returns, businesses and employs will increasingly head south to expand. This will further increase the economic benefits already realized in the shale industry.

A second shale boom will also greatly help Mexico’s economy, which has been suffering from anemic growth the last few years. The increased investment will directly provide much-needed jobs to Mexican workers who normally would migrate north. Despite fears that allowing foreign investment will take jobs away from domestic workers, regulators require companies that win the bid on exploration contracts to meet a national content requirement of 25 percent at the beginning of the contract and 35 percent several years later. This means 25 percent and then 35 percent of the goods, services, and labor used by foreign companies must come from Mexico.

In addition to employment gains and economic growth, increased investment will bring down energy costs to Mexican consumers. Mexico currently suffers from high gas prices that are double the prices in the United States and Canada. Increasing production in shale gas fields will increase the supply of natural gas and consequently bring down prices in Mexico. This not only benefits consumers but also industries that rely on natural gas for electricity.

Challenges and the Downside of Energy Reform

Despite the positive economic impact the energy reform laws bring to America and Mexico, there are also challenges and negative consequences. The biggest is the negative environmental impact of increased oil and natural gas extraction. Fracking impacts the environment in a variety of ways including air pollution and ground water contamination. Higher oil consumption will increase the amount of carbon dioxide in the atmosphere and further exacerbate global warming. These environmental issues needed to be weighed against the potential economic gains of increased energy production.

Even if the economic benefits outweigh the environmental costs, several factors may make increased foreign investment difficult. Mexico’s security problems pose a threat to U.S. businesses that want to operate in the country. Much of the untapped shale reserves reside in areas of the country that are at risk of cartel violence. While companies can hire private security to protect their projects, this added risk could make companies more reluctant to invest.

In addition, low oil prices threaten to undo the American shale industry. Shale oil and gas is more expensive to extract than other conventional methods, making the break-even price of shale oil $58 for the average shale producer. With current Western Texas Intermediate crude prices at $48.84, many shale projects are unprofitable. If prices stay too low for the foreseeable future, business will unlikely invest in Mexican shale production.

However both of these challenges are manageable. Despite cartel violence, many international oil companies have dealt with security issues in politically unstable countries before, such as Iraq and Nigeria. While smaller companies that operate in Texas do not have the experience to combat security threats, international companies will be able to operate in cartel zones safely. And if these companies invest in regions with high cartel violence, the increased economic activity and employment may drive people away from working in the cartels, making the area safer.

Falling oil prices also will most likely not completely prevent foreign investment from coming into the country. According to Rystad Energy, even though oil prices are falling, the break-even costs of extracting shale oil has also fallen in the fast few years. Innovation and efficiency can bring down the cost of drilling further, making low oil prices manageable.

These challenges represent a temporary setback for foreign investment into Mexico that will delay the development of shale oil and gas wells. Eventually, international companies will begin to invest in Mexico and bring fracking and horizontal drilling techniques with them. While the use of fracking and horizontal drilling will most likely not have the same magnitude of an effect on Mexico as it has in the United States, over time Mexican oil production should begin to recover and reverse the downturn in oil production. Long term, oil production may recover to its 2004 peak of 3.8 million barrels a day. If the projects by the Energy Information Agency are correct, by 2040 Mexico will be producing 3.7 million barrels a day, just 100,000 below the 2004 peak. Overall, these reforms should revitalize the oil industry and bring economic benefits to both the United States and Mexico.